In 2011, superstar investor Warren Buffett made headlines not for his investment recommendations, but for his opinion that top income tax rates are expected to increase significantly.
Buffett proposed the Buffett Rule, which would impose a minimum effective tax of 30% on those with incomes above $ 1,000,000. This was supported by the then president Barack obamaBarack Hussein Obama: Our strategy to combat terrorism from a distance is riskier than rewarded and Democratic presidential candidate of 2016 Hillary ClintonHillary Diane Rodham Clinton Clinton indictment reveals ‘bag of tricks’ Lawyer indicted in Durham investigation pleads not guilty Lawyer charged with lying to FBI in connection from the Durham PLUS survey.
Buffett reiterated his opinion earlier this year, arguing âThe rich are definitely under-taxed compared to the general population. “
Buffett could be considered the New Age Robin Hood. But it’s not like Buffett put his money where his mouth is. For years, Buffett has exploited all tax advantages to minimize his tax payments, including unrealized income offsets.
Buffett does this by shifting the income growth from his assets to the appreciation of the stock price of Berkshire Hathaway, which is the company he runs. Tax is not due until the inventory is sold.
And speaking of Berkshire Hathaway, the Buffet company paid off one of the lowest corporate tax rate last year among all major US corporations. Buffett’s Berkshire Hathaway paid a -8 percent tax rate, which was the third lowest tax among Fortune 100 corporations.
Federal tax rates on top earners are relatively low not only because of the tax considerations used by Buffett, but also because capital income is often taxed at a lower rate than labor income.
Contrary to the opinion of Buffett and those of the Democratic presidential candidates Sen. Bernie sandersBernie SandersSunday Shows Preview: Coronavirus Dominates As Country Battles Delta Variant Democrats Urge Biden To Commute Sentences Of 4K People In Home Lockdown Briahna Joy Gray: Pushing Towards Major Social Spending Amid Pandemic Has Been “Short term” PLUS (I-Vt.) And Sen. Elizabeth warrenElizabeth Warren’s Federal Reserve officials’ stock trades prompt ethical review (D-Mass.), Low capital income tax rates are a good thing.
If Buffett’s recommendation were implemented, the US economy would decline, capital would move overseas, and the costs would be borne by workers.
Standard economic logic robustly states that capital income should be taxed at a very low rate, if at all. This conclusion is not based on political considerations. Rather, capital income is the economy’s most inefficient source of tax revenue. Economists do not like to tax capital income because it generates relatively little long-term income as it distorts economic decisions, especially decisions to invest and innovate.
The main reason is that investing is how people support future consumption. Taxing capital year after year means an ever increasing tax on future consumption. Consider an investor who has a 10-year planning horizon. Taxing capital income at a rate of only 20% for 10 years generates a tax rate of around 200% on this future consumption. High tax rates on capital income lead investors to abandon heavily taxed assets and lead to capital flight.
European countries, which tend to have much higher tax burdens and much larger public sectors, tax capital income at relatively low rates. The taxation of dividends concerns 23.5% in Europe, the median capital gains tax rate in Europe is 15 percent and the average corporate tax rate in Europe is 22.5 percent.
And for those who believe the rich will end up paying higher taxes on capital income, think again. The impact of taxing capital income is ultimately borne by the workers, even if the tax is levied on capital.
Empirically, investors have demanded a fairly consistent after-tax return. As tax rates rise, they reduce investment until the required after-tax return is restored. Lower investment means lower capital per worker, which reduces workers’ productivity and wages. Taxing capital income is not in the best interests of working people.
Countries that have heavily taxed capital income, and / or taxed wealth, have suffered and have backed down. In the 1940s and 1950s, Great Britain taxed capital income at almost 100%. Investment fell to near zero and economic growth declined dramatically until tax rates on capital income were aligned with those of other major countries.
In 1992, 12 large European countries taxed wealth. In 2017, only four of these countries (France, Norway, Spain and Switzerland) still taxed fortune. Experiences from other countries have been hampered by implementation issues, including valuing assets that are rarely traded, such as art and jewelry, and lower than expected revenue collection.
There is a much more efficient method of taxation, which weighs slightly on low wages. Introduce a national sales tax and expand the earned income tax credit. This reduces the tax burden on low-income households. It is also a tax that is much more difficult to escape than many other taxes, even for the Warren Buffets of the world.
Lee E. Ohanian is Professor of Economics and Director of the Ettinger Family Program in Macroeconomics Research at UCLA. He is also a Principal Investigator at the Hoover Institution at Stanford University.